Hawaiian Electric Industries Inc (HE) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the first quarter 2010 Hawaiian Electric Industries earnings conference call. At this time, all participants are in a listen-only mode. We will facilitate a question and answer session towards the end of this conference. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Ms. Shelee Kimura, Manager of Investor Relations and Strategic Planning. Please proceed.

Thank you, and welcome to Hawaiian Electric Industries first quarter 2010 earnings conference call. I am Shelee Kimura, and joining me today are Connie Lau, HEI President and Chief Executive Officer, Jim Ajello, HEI's Senior Financial Vice President, Treasurer, and Chief Financial Officer, Dick Rosenblum, Hawaiian Electric Company President and Chief Executive Officer, and Tim Schools, American Savings Bank President, as well as other members of senior management. In today's presentation, management will be using non-GAAP financial measures to describe the bank's operating performance. Our press release and the slides accompanying this webcast, which are posted on our Investor Relations website as indicated in our earnings release yesterday, contain additional disclosure regarding these non-GAAP measures, including reconciliations of these measures to the equivalent GAAP measure. Forward-looking statements will also be made on today's call. Please reference the accompanying disclosure to the webcast slides located on our website. I'll now turn the call over to Connie Lau.

Thanks, Shelee. Aloha, and thank you for joining us today. As you can see from the information we released yesterday, we had a very solid quarter. First quarter earnings were $0.29 per diluted share compared to $0.22 per diluted share in the first quarter of 2009. Both the Utility and the bank contributed to higher earnings. Here on slide three, we highlight the primary earnings drivers for the first quarter 2010 relative to the same quarter last year. Jim will go over the financial results in more detail shortly, but let me give you some color on just a few items. As you can see, first quarter results are primarily characterized by much needed rate relief at HECO. This includes the second quarter interim rate relief for CT-1 that we were awaiting when we did our last earnings call.

Revenues also benefited from higher kilowatt hour sales due to more normal weather, relative to the unusually cool weather in the first quarter of 2009. Sales were still below our rate case level. As expected, O&M expenses were higher compared to the same quarter last year, but increased at a lower rate than our full year expectation for 2010. This is due to timing, and therefore we expect O&M to catch up to our expectations by the end of the year. At the bank, we saw our third consecutive quarter of provision in the $5 million range, which is encouraging, but we remain cautious until a Hawaii economic recovery is clear, especially since consumer credit tends to lag. As expected, we had some pressure on net interest income and net interest margin. This will continue as we hold excess cash and until we can redeploy the cash effectively.

Slide four summarizes our strategic focus for 2010. These have not changed, and I include them to reiterate our priorities for the year, and to say we continue to make progress at each of our companies. Let's turn to the highlights of our year-to-date progress on these priorities. With respect to the Hawaii Clean Energy Initiative and our regulatory progress, decoupling continues to be one of our highest priorities. It equips us with the opportunity to regain our financial strength and fulfill our critical role in carrying out our state's energy policy that will benefit customers and Hawaii's economy, protect the environment, and increase our energy security. On February 19, we received commission approval on decoupling, and once the PUC issues the decision on the details of implementation, we will have the ability to move forward with the new regulatory model. The 2010 MECO and HELCO rate cases are both on schedule for an interim decision and order in August and November respectively.

As for HECO's 2011 rate case, plans remain to file during third quarter. This rate case is a requirement under the decoupling decision and order and is important to the effective implementation of decoupling. It should set the appropriate base upon which the decoupling mechanism for our largest Oahu systems are calculated. On our HCEI renewable goal, we are pleased with our 2009 achievement of 19% compared to our December 2010 goal of 10%. The 19% is among the highest of US utilities and is approximately evenly split between renewable generation and energy efficiency. Slide six shows our actual versus allowed ROEs. Although we made good progress in the first quarter to improve earnings, our ROEs continue to significantly lag our allowed rates of return. We are focused on narrowing the gap between our actual and allowed ROEs, as we implement sales decoupling, revenue adjustment mechanisms, and general rate increases.

Moving to the bank, as many of you already know, Tim Schools, ASB's President, has announced his intention to resign following the completion of the bank's performance improvement project, which should be substantially done by mid-year. We currently have an executive search ongoing to ensure ASB continues as a high performing bank into the future. Turning to the bank's progress on strategic initiatives, the performance improvement project continues to make solid headway. As you can see here on slide seven, the expected reduction in net interest margin in the first quarter also impacted return on assets. However, first quarter 2010 results continue to reflect significantly improved performance since the start of the project two years ago and compares well against our high-performing peers. In addition, our non-interest expense reductions are beginning to show up in our GAAP results. The progress of the performance improvement project is also starting to be reflected on a GAAP basis for pretax, pre-provision income. Using GAAP results, first quarter 2010 pretax, pre-provision income was $108 million, $11 million higher than the same quarter two years ago. On an adjusted basis, the first quarter is $21 million higher than two years ago. The decrease from the linked quarter, on an adjusted basis, is primarily due to the decline in net interest margin I discussed earlier.

Looking forward, we have adjusted our targets for the impact of the non-sufficient fund, or NSF legislation that will become effective in July of this year. The legislation prohibits banks from charging NSF fees on debit cards and ATM transactions unless the customer gives consent to opt in to the bank's overdraft services. Therefore, the industry expects a significant reduction in fee income related to these transactions. Such legislation was not contemplated when our target was originally established. As a result, we are reducing our target from a range of $120 million to $130 million, down to $110 million to $120 million to be achieved in the next 12 to 24 months on a run rate basis. Jim will show you some detail on that in a minute, so let me break here and ask Jim to update you on our Hawaii economy and financial results.

Thanks, Connie. First, the economic backdrop. On Slide 10, we start with Hawaii's tourism industry, a significant driver of the Hawaii's economy and also one of our largest utility customer segments. Hawaii is showing signs of stabilization, and local economists expect a 2.9% improvement in arrivals this year. We have seen four consecutive months of year-over-year visitor arrival increases, with March 2010 visitor arrivals increasing 9% over the same month last year. Hawaii unemployment is relatively low at 6.9% in March 2010 compared to the national average of 9.9% in April 2010. This statistic is for Hawaii as a whole, Oahu is comparatively stronger than the neighbor islands as shown on this slide.

Sales in the Oahu residential real estate market have been very encouraging. In March 2010, Oahu home sales volume increased by 32% and the median price rose 4% to $599,000 compared to March 2009. In Oahu, we are only down 13%. On the island of Maui, home sales volume increased by 25%, but the median price decreased by 9% to $460,000 compared to March 2009. Slide 13 shows local economists' expectations for the economic indicators. With signs of stabilization, most economists expect a gradual recovery starting in 2010. While we are encouraged by the economic indicators, we remain cautious. Turning to first quarter financial results, HEI earned $27.1 million, or $0.29 per diluted share in 2010, compared to $20.4 million, or $0.22 per diluted share in 2009. Both operating companies' earnings were up just over 25%, with consolidated results up 33% for the quarter.

At the utility, net income was $18.1 million for the quarter, compared with $14.1 million for the first quarter of 2009. Primary drivers for the increase were $9 million of rate relief at our Oahu utility and $2 million related to normalized kilowatt hour sales. This was partially offset by $3 million of higher O&M expenses, excluding DSM, $4 million higher financing costs and $1 million higher in depreciation expense, primarily due to the addition of two new generating units, CT-1 and ST-7 in 2009. Kilowatt hour sales were 1.9% above the same quarter last year, primarily due to more normal weather this year. For the year, we continue to expect kilowatt hour sales to be down 0.9%. Note that once decoupling is implemented at all three utilities, kilowatt hour sales will no longer impact earnings significantly.

O&M expenses for the first quarter of 2010 were 7% higher than the first quarter of 2009, excluding DSM. This is a lower rate of increase than the 16% we guided last quarter for the entire year of 2010. The difference in the actual rate of increase in the first quarter results relative to our full year estimate is due to the timing of certain generating unit overhauls. Thus, we continue to expect annual O&M expense to be at the levels previously indicated. Now, I'll sum up the key earnings drivers in 2010 for the utility. The regulatory outcomes and their timing will drive our financial results in 2010 and beyond. Getting requested decisions on our rate cases is important, but not only because of the rate relief itself, but because they provide the basis for sales decoupling. Decoupling will give us a real opportunity to earn fair returns and help narrow the gap in our actual ROEs compared to our allowed ROEs, while also supporting our state's Clean Energy goals. We continue to expect kilowatt hour sales to be down 0.9% for the year. However, HECO Oahu revenues will not be impacted by sales once decoupling is implemented and HELCO and MECO sales will be reset in general rate cases later this year.

With O&M expected to be up 16% excluding DSM, the revenue adjustment mechanisms HECO Oahu once implemented will provide a partial offset for the O&M increases in 2010, although very small compared to the increase expected. The revenue adjustment mechanism from plant additions should also help this year. Turning to the bank on slide 19, first quarter 2010 earnings were $13.7 million versus $10.9 million in the first quarter of 2009. Major drivers, after tax, were $2 million lower provision for the loan losses and $2 million lower non-interest expense, partially offset by $1 million lower revenues and $2 million lower net interest income was offset by $1 million in higher non-interest income. Compared to the fourth or linked quarter 2009, this quarter's results were $1.1 million lower, excluding the private issue mortgage-related securities portfolio liquidation. Primary drivers after tax were $1 million lower net interest income, $2 million lower non-interest income, offset by $2 million lower non-interest expense resulting from the performance improvement project.

The Company's net interest margin for the fourth quarter was 4.18%, down 9 basis points from the fourth quarter 2009. Reversals of accrued interest for loans that have become 90 days past due, combined with high cash levels from the fourth quarter sale of our private mortgage-backed securities and our continued planned reduction of the 30-year fixed rate mortgages are putting temporary downward pressure on net interest margin and income. However, our margin continues to be one of the strongest in the nation due to our high quality, low cost, deposit funding base. Unlike most banks, our loans are completely funded by deposits and their cost is extremely low with a cost of 13 basis points for core deposits and 45 basis points for total deposits. We continue to monitor the interest rate environment and are cautiously redeploying our cash to higher earning asset categories when we think it appropriate in light of our interest rate risk parameters. With the prospect for higher interest rates at some point in the near future, the bank continues actively working to improve its interest rate sensitivity.

Over the past 15 months, the bank has sold nearly all of its 30-year fixed-rate mortgage reduction, lowering balances from $2.8 billion in December 2008 when we made the decision to sell our mortgage reduction to $2.3 billion at March 31, 2010. The cash that has been generated from the sale of ASB loans has been put to work primarily in shorter duration loans, or held in cash. With the available yield of cash at 25 basis points, we continue to look for interest rate-friendly ways to implement our yield, while continuing to improve our interest rate. (inaudible) home equity campaign where we offer a 1% introductory rate and we priced this to a market rate of 4.5% after one year, or prime base variable rate, whichever is higher. We felt this was a unique opportunity, as ASB only has about $300 million of home equity earning balances, many of which were issued without floors. So the weighted average yield is 3.73%.

Our results have been tremendous. Attracting many new customers to the bank, with $400 million in applications. With this amount, we have booked or conditionally improved $169 million. Typically utilization runs about a third of the line amount, so this would equate to over $50 million in potential interest rate from the new assets. $75 million of the $400 million in applications is still in review. Importantly, the average FICO of the approved loans is over 770, the average debt-to-income is below 34% and the average loan- to-value is below 55%. The bank has also purchased a modest amount of callable government debentures with a step yield and maximum three-year life. Nevertheless, we still ended the quarter with over $200 million of available cash.

Moving onto provision, on Slide 21, in this quarter, the bank recorded $5.4 million of provision for loan losses, essentially even with the third and fourth quarter of 2009. The quarter's provision was largely due to net charge-offs of residential lot loans, and one to four family mortgages, primarily on the neighbor islands. However, as I will show you shortly, our overall net charge-off ratio remains low. On Slide 22, we show our efficiency ratio and non-interest expenses on a GAAP and adjusted basis. We also compare our efficiency ratio with our peers and high performing peers. As you can see, our efficiency ratio of 58% on a GAAP basis and 56% on an adjusted basis is starting to trend favorably with our peers. This quarter, non-interest expense is reflected and prudent, however, our adjusted efficiency ratio was even with the last quarter since lower expenses were offset by lower net interest income. First quarter 2010 adjusted non-interest expenses are running at about $36.7 million for the quarter, or $147 million annualized. You will also notice that we are reporting a nice improvement on GAAP results as well, with $38 million, or $152 million of annualized non-interest expense.

Turning to our balance sheet on slide 23, here we show you ASB and our peer banks in terms of asset and funding mix. Since the last available data for our peer set is as of December 31, 2009, we are showing you ASB comparative data for December 31, 2009, which is very similar to ASBs March 31, 2010 balance sheet. As we mentioned, a key differentiator for ASB versus the industry is our loyal, low-cost deposit base. At the end of the first quarter, 65% of our assets were funded with core deposits, including 28% funded with free, or low-cost checking accounts. As a result, we have very little wholesale funding. These are very strong numbers in the banking industry that benefit the bank by providing more profitability than others, without taking credit risk where others would have to stretch on loans to generate the same net interest income. It also provides better liquidity, as core deposits tend to be more stable, and we have a larger percentage of our FHLB lines that we can tap.

On Slide 24, the nonperforming asset ratio increased 28 basis points in the first quarter, to 213 basis points, reflecting a rise in nonperforming [resi] one to four family and commercial market loans, primarily on the neighbor islands. This is consistent with the higher unemployment rates and the decline in the market values of the neighbor islands, which I shared earlier. Our primary credit risks continued to be the $89 million of lot loans, $116 million in family and residential loans purchased and $335 million of neighbor island one to four family mortgages produced from 2005 to 2007. Our net loan charge-offs were 62 basis points in the first quarter of 2010, compared with 66 basis points in the full year 2009. First quarter 2010 net loan charge-offs of $5.7 million were primarily attributed to neighbor island residential, one to four family and land lot loans.

Now turning to valuation of ASB, as ASB approaches the final stages of the performance improvement project, we expect ASB to perform in line with our high-performing peers on ROA, NIM, efficiency, asset quality, capital levels, although not on revenue growth, as Hawaii is not a high growth market. In the appendix, we have provided you with a pure analysis, summarizing how ASB is tracking against our high performing peers. With Management targeting consistent results at a high performing peer level going forward, and as more bank valuations transition back toward earnings multiple, as opposed to tangible book multiple, we have illustrated what ASBs valuation per share would look like if one assumed a PE multiple consistent with our high performing peers. Here we show that our average sell side valuation for ASB is approximately $6 a share, or the equivalent of an earnings multiple of 8.7 times 2011 consensus. If the bank was valued at a multiple consistent with high performing peers of 14.4, or bank of Hawaii's multiple, 15.3, and assuming 2011 consensus estimates for ASB, the value assigned to the bank would be roughly $10 per share. We recognize we are just starting to produce high performing results, but our goal is to show consistent high performing metrics over time, and we hope to achieve this kind of valuation in the future. On Slide 27, we illustrate a simple way to think about earnings potential of the bank 18 to 24 months from now, assuming no changes in the yield curve. We start with the first quarter adjusted annualized pretax, preprovision income and layer in the various components we expect in the next three to 24 months.

After the estimated impact of the FISERV savings, investment of our excess cash at a rate of 2% to 4% and expected savings from consolidation of real estate, we get to a pretax, preprovision income of $123 million to $128 million per year. Therefore, without the NSF legislation, you can see that we would have expected to achieve our original target. Assuming 0% to 25% success in offsetting the reduction in NSF fees, the pretax, preprovision income goes down to a range of $108 million to $117 million. Our provision expense, if you assume the credit cycle will normalized over the next 12 to 24 months, then the annual provision rate decreases to $5 million to $8 million, which is high compared to the average 2002 and 2007 provision of $1 million, the earnings potential of the bank would be $63 million to $71 million per year. These estimates are subject to changes in the yield curve, which could affect net interest income. I'd like to highlight that this is generally consistent with the estimate we gave you two quarters ago of $65 million to $70 million, even with the new offset related to the NSF legislation and the elimination of our private-issue mortgage-related securities.

I'll sum up the bank's earnings drivers for 2010. As with all banks across the country, we are keeping a close eye on legislation, the economy, credit cycle and interest rates. With the NSF legislation becoming effective in July 2010, we expect fee income to be lower in the second half of the year. Assuming zero customers opt in, the after tax exposure is approximately $9 million on an annual basis, or approximately $4.5 million in 2010. This is the worst case, but as many in our industry, we continue to evaluate the expected level of impact, and the strategy is to recover that income. Our net interest margin, there will be pressure on margin until we invest the $200 million of excess cash on hand. On the funding side, we expect our low-cost and loyal deposit base to continue. Although we are encouraged by the economic signs of stabilization, and economists expect gradual recovery in the local economy starting in 2010, we expect provision income -- expense, rather, to remain in the range of the 2009 provision of $23 million, which excludes the provision expense related to the single commercial credit.

On non-interest expense, we expect $1 million more FISERV conversion expenses in the second quarter, followed by $6 million in annual savings starting June 1 or approximately $3 million in 2010. We also expect some severance and real estate buyout costs to continue through end of the year. Once the project is completed this year, we expect to reach our target of an annualized non-interest expense run rate of $140 million to $145 million. Now, on to an update of liquidity and financing plans. With respect to short-term borrowing capacity between the holding company and the utility, we had $215 million of remaining capacity at the end of the first quarter. Last week, both HEI and HECO executed new three-year credit facilities totaling $300 million. This replaces the $275 million in facilities that were to expire in March of 2011. Last quarter, we provided you with our holding company sources and uses forecast for 2010, and we have no changes to the forecast to report. In addition, we still do not anticipate equity requirements beyond drip for the next three years, based on our current assumptions and estimates.

That brings me to the first quarter dividend. The Board declared a dividend payable June 10 to holders of record May 21, the ex-dividend date is May 19. Our dividend yield remains attractive to both utility peers. As of yesterday's close, our dividend yield was 5.4%. Now, let me turn the call back over to Connie.

Thanks, Jim. We believe the utility and the bank are at an inflection point and we are excited about our future. At our utility, we continue to pursue a comprehensive redesign of our regulatory model to ensure a financially viable utility, strong enough to attract the capital necessary to execute our state's public policy of reducing Hawaii's dependence on imported oil. We expect to narrow the gap between our apparent and allowed rates of return, as the decoupled model is implemented over the next two years. This should result in attractive earnings growth. With a decoupled model, the quality of earnings should significantly improve as well. We expect earnings to be less volatile and more predictable. In addition, we expect rate base to grow over time, as we strengthen our system to accept increasing renewable generation and increase our equipment replacement rate to address our aging infrastructure.

At the bank, the core business is performing very well and strengthening every day. Our bank has a low risk profile, strong balance sheet, terrific funding base and a simple business model. Given our profitability improvements to date and expectations over the next year, we expect our bank to perform in line with high performing peers, and achieve a pretax, preprovision rate of $110 million to $120 million, including the impact of NSF legislation that will affect the industry as a whole. We expect to see earnings benefit as the Hawaii economy and credit environment improve. And finally, we continue to maintain our dividend at an above-average yield. In summary, we believe we are well-positioned to deliver attractive risk-adjusted returns to our investors. I'll now open the call up to questions and ask Jim, Dick and Tim to join me in answering your questions.

(Operator Instructions) And your first question comes from the line of Paul Patterson, representing Glenrock Associates. Please proceed.

Good morning, guys.

Good morning.

I want to touch base on the NSF legislation and its impact. It looks like, if I look at that slide, it's $11 million to $15 million of potential annual impact pretax. What change -- what's the variation between $11 million and $15 million in terms of what it's potential negative impact on an annual basis would be?

The annual number is the $15 million and the $11 million is just 25%, as Jim had explained in the note. The assumption that those people would opt back in.

And this is Tim. That's just a total guess. So, when you read industry literature, it's all over the board. If you go back to December, I think that JPMorgan was early, and if I have it correct, I think JPMorgan said hey, we're going to assume that we lose 50%, 5-0. I've seen, I've seen things in the American Bank or in different trade rags, that people are estimating anywhere from a 30% to a 60% success rate. For us, main thing we wanted to do today was just put out there, and let you all know that we make $15 million from this and we're conservatively saying 25%. That would be at the lower end of what people in the industry are estimating, but we don't know anything better to give you.

And there are also many strategies that banks are considering to make up that difference.

Yes, that's what I was going to ask you. What strategy -- do you think that's a possibility with you guys?

Without a doubt. There's a lot of stuff, and I don't want to get -- dominate the call on the bank, but we made a lot of good progress. And when we started, our pretax, preprovision was maybe $90 million, and now we think it's going to be in that $110 million to $120 million. So, we've already added about $30 million of pretax, preprovision even after this. So, you're not going to get that kind of lift in the future, but there's still a lift.

There's still things -- I was in our Honolulu Wal-Mart branch the other day, and Wal-Mart charges $3 to cash government checks for people, should be very low risk. And I talked to our assistant branch manager, who is from First Hawaiian, used to work there. And she said it's an opportunity for us, that most of the banks in the state charge $3 to cash government checks. We're not doing that yet. Now, is that going to add $15 million? No. But could it add $500,000 a year? Maybe. So, we've got a list of smaller items. So, the Company still has things we're going to continue to in the next year, two years, three years, but it won't offset the $15 million. But certainly will help.

Okay. Okay. And that's not in the numbers that you guys have projected here. Is that correct?

Correct. Correct, just trying to be conservative and just be open. That best information we have today, this is what we have to give you.

The $200 million and the redeployment of that, did I understand correct that you guys are saying that you guys are earning 25 basis points on that?

Yes, and I understand you called last night and asked some questions related to all of this and there's a lot that's changed within the balance sheet the last two years. And just real quick for everybody, we started at $6.8 billion, and we said there was two things with the PIP. One was our expenses were above banks our size and we've tackled that. We're about there. Number two was, ASB had oversize wholesale asset and wholesale funding book, which when you looked in combination, it was earning little to nothing, but utilizing a lot of capital. So, at the outset, I think we estimated, Connie, to reduce about $1.6 billion. But when we looked at the losses it would take to get it off, we said let's do $1.4 billion now and let's let about $200 million roll off the next six to 12 months. If you remember back, that's what we said.

Right.

And that was the summer of '08. So, we thought after that, if you do 6.8 minus 1.6, after the $200 million of natural runoff, we thought we would end up about 5.1 or 5.2.

Right.

And the reason we were going to let that last piece run off, is it had the highest loss and we didn't want to take that loss in the summer of '08 when we knew these things would mature naturally. Let's just not pay the fee and let it roll off. What happened during the fall of '08, as you all know, the economic crisis got a lot worse. And so, in December of '08 and January of '09, mortgage rates went to historical all-time lows. You could get a 30-year fixed-rate mortgage for 4.5%. So, unexpectedly during this performance improvement project, refinances shot up.

Well, that affected two things for us. One is our securities portfolio, the prepayment speed shot up. One of the things I heard you ask last night, the prepayments on the cash flows on our securities escalated and they were much higher this time last year, putting more cash back to us than before, or currently, right now. We got that cash and you had two options with that cash. You could go buy securities and put duration risk on, which would help earnings now, but hurts you two or three years down the road when rates go up, or you could sit on cash. We chose to sit on cash because we knew the expenses were going to get better and be able to provide the earnings that we wanted.

Secondly, is our mortgage book. ASB has a big mortgage portfolio. Our refinances went up really big. We had options on that. We could either refi them and put 4.5% 30-year loans on our books, which again would -- we would have earned more than we otherwise did. Before five years from now, it would have kicked us in the teeth. Or we could have said let's sell those to the secondary market and hold cash. So, versus the summer of '08 and the original PIP, we got a little wrinkle in the strategy. And so what we decided to do was be very conservative, improve our interest rate risk, let's focus on the expenses to hit our numbers and we held more cash than we thought we would have at the outset.

During this last year, we started to think about what can we do with this cash? We did not want to put undue interest rate risk on the bank, so the first thing we talked about with the Board last summer is let's let some of our CDs run off. They were costing us 2% to 2.5%, so we figured we could get a risk-free return of letting those go, and we get 2% to 2.5% with no credit risk. So, that took our balance sheet from the 5.1 to 5.2, down to 4.9. That's why we went further. We don't see the Company getting smaller. We're about as small as we can get.

And last point, in the first quarter, for the first time, we started making additional investments. You didn't see it in the quarterly results. It'll show up this quarter. We did three things. One is we started the home equity campaign that Jim summarized. We got $400 million of applications in two months, with very high credit quality. We expect to get about $50 million to $80 million of earning balances out of that that will start showing up in second quarter. Number two, we can't sell all of our mortgages forever. We've got to start putting some on and we made it past the worst cycle of the 4.5%. 30-year mortgages are now -- they're not great, but they're now 5.2% to 5.5%. So, we're starting to put some on, still being cautious. And then Paul, what was the third one?

Investments.

Investments. Jim mentioned this. We started putting on some government ventures that have a three-year final maturity, they're callable and they're 1% the first year, 3% the second year, and 5% the third year. So again, trying to be interest rate friendly and not going right up on the curve. So, apologize for all of that, but I heard you ask a real complex question, so wanted to make sure we covered that.

Well, okay, you did. So, I won't take up a lot more time. But the deposits continue to fall because of what you were saying, the rolloff of the CDs. Are you concerned about the continued -- I mean where are you guys going to be happy in terms of new deposit level is what I'm wondering?

We're tickled to death on the deposit levels. Most banks look at core deposits and then total deposits. Our core deposits continue to grow every quarter. You tell me what deposit number you want June 30. I can give you whatever number you want, because all I have to do is put a big CD rate out there. And so banks -- CDs are an important funding source, but they are the source of last choice. And so, that actually has been our investment decision the last year. Instead of buying mortgages or securities, we've chosen, in theory, to buy CDs and get rid of them.

So, again, I can bring in as many CDs and make your deposit number whatever you want. We're really focused on core deposits. I have 108,000 free checking accounts and 24 months ago, I had zero. And Hawaii grows 1% a year. So, we're getting a lot of new customers and moving households to ASB. The average balance on these free checking accounts are $1,600 and all that money is free.

Paul, our major concern is to optimize our cost of funding and so what we're really focused on, as Tim said, is those lower costing deposits. And the wholesale funding and the certificates of deposit tend to be closer to market rates.

Okay. So, the CDs are not going into the core deposits as they unwind?

Right.

You're actually getting more deposits coming in, is that what you're getting?

No, some of both. Good question. Good question. Last summer, when we decided to roll off our CD balance, probably the weighted average was 2.5% and probably $70 million to $80 million was maturing a month, and we really lowered our rates, as did the other banks in the market. The other banks are doing the same strategy. We look at everybody's rates every week. And so, all of our CD rates are the same place and they are rolling their CDs off also. And they're flush with cash as well. And so, good question, when they mature, if you had a CD at 2.5%, Paul Patterson, we're seeing two trends.

Some percentage say I'm going to go somewhere else, Edward Jones, wherever. They are not really going to First Hawaiian or Bank of Hawaii because they're offering the same rates as us. But, good question, a good portion is rotating into checking, savings, other products. So, we're winning by giving a lower cost of funds, either by them leaving or going into free checking or going into savings, which is 10 basis points.

Okay.

And just because interest rates slide, we would expect some of that flow that will naturally go back into certificates as well.

Okay.

But the whole point was for us to retain the consumer relationship.

Okay. Well, I'll let some other people ask questions. I appreciate the detail. Thank you.

Your next question comes from the line of [Eric McCormick] representing Presidio Asset Management. Please proceed.

Hi. Good afternoon. The moving to nonperforming assets, could you give a little detail on that? All other ASB loans category, it seems to be increasing trend.

Yes. It went up $9 million for the quarter and it is one commercial credit that is about $3.5 million to $4 million. It's a company that entered bankruptcy in the first quarter and we are the only secured creditor to them. So, it's a good franchise and is viable, so we feel pretty good about our collateral position and our outcome on that. So, we currently don't expect much or any loss on that loan of that potential increase. And that is $3.5 million to $4 million of the $9 million increase. The remainder would primarily be just residential houses or lots on the outer islands. The lots, we've been -- when we take a loss experiencing up to 30% to 50% losses on those lots and on the residential mortgages, we've been experiencing very little loss. The bank, typically, most of the mortgages are on Oahu and even on the outer island, when we look at the production we do, generally it's about a 65% loan-to-value. So, outer islands have fallen anywhere up to 40%. So, with the amount of equity that's at origination, we're seeing very little loss on first mortgages.

Okay. And without going, getting too theoretical, it seems like you're shortening the duration quite a bit on the liability side of the bank's balance sheet by -- with the strategy you mentioned of letting CDs roll over into savings accounts. How does that increase -- how does that impact the interest rate sensitivity at the liability side? Because it looks like we're pretty fixed on the asset side and--

Actually, actually interestingly, that's not the case. We've materially improved our interest rate risk, even the OTS has recognized that. And that's part of the reason. One is, remember, as Jim pointed out, we had $2.8 billion of 30-year fixed rate mortgages and now we have $2.3 billion. So, on the asset side, we have much less longer duration. So, in addition to $500 million less, I also have $200 million of cash. So, very much shortened the lives of the asset, on the asset side.

Interestingly, on the deposit side, our CD -- most CDs in America now -- used to be that you had three, five year CDs. People don't really do that anymore, and so most CDs across the country are 12-month CDs. So, they're not really long in duration in that sense in the first place. But what's interesting, is when you look at our CD duration today versus our CD duration of three, six, nine months ago, our CD duration is actually longer. It's extended out, so we've improved our position.

And Eric, I'd just add, on the core deposit side, the core deposits tend to be very sticky in Hawaii. So, while you think they may be checking accounts where people can pull the money out tomorrow, which they are, they actually tend to leave the money a lot longer.

Okay, all right. That makes sense. Thank you.

Your next question comes from the line of Michael Goldenberg representing Luminus Management. Please proceed.

Good morning.

Hey, Michael.

I wanted to focus quickly on the utility. You've had a stipulation out there for decoupling for a while, but the commission hasn't taken action yet. What do you think is the holdup? And when do you expect that to take place?

This is Dick Rosenblum. The holdup, as you refer to it, is merely the staffing size at the commission and their capacity to produce decisions. We have a very, very small staff at the commission. In total, including the commissioners, it's about 37 people, and it just has to process through the system. We would expect the decision with the implementation detail shortly. I can't pin it down any better than that, but they are working on it, they do know it's a high priority, and they are expect -- we are expecting it to come out fairly shortly.

Okay, and on the HELCO and MECO rate cases, can you please give us an update of where you think you stand in discussion with the consumer advocates?

This is Shelee Kimura. Those cases are being worked through currently. We have time in the schedule for discussions with the consumer advocates. So, at this point, it's a little bit premature, but we're working through the case. As Jim noted previously, we do expect interim decisions in August and November for the MECO and HELCO rate cases.

Okay, got it. Thank you very much.

Your next question comes from the line of Bobby Bohlen, representing KBW. Please proceed.

Hi. Thank you. Just two quick questions on credit. When I'm looking at the nonperforming loans, does that include restructured loans or are restructured loans taking place? And if so, are they somewhere else in the loan category?

It includes restructured loans that are 90 days past due.

Okay. Is there a significant number of restructured loans that are not 90 days past due that would not be included in that?

Not significant. I don't know if it's 20 million, 30 million. It is a number. It's largely our lot loans. We started at 120 million or 130 million of lot loans and we've been working diligently. There's an interesting population. Those are three-year loans.

There's an interesting population that can continue to handle the monthly payments, but when they mature after three years, let's say you have one, the property has fallen 50% and so, for us to re-underwrite it at a 60% loan-to-value, you'd have to pony up more equity to get your loan-to-value appropriate. People don't have equity to put back in the deal, but they could handle the original monthly payment from the beginning. So, those are the ones we're having to modify and many of those are remaining current, so they would not be included. And then unfortunately, some of those that you modify, six to 12 months later, they fall past due again. So, they are in the nonperforming. It's not a huge number, though, Bobby.

Okay, okay. And then second follow-up to that, early stage delinquencies, what are you seeing in terms of both consumer and commercial for early stage?

Actually this quarter, 30-day and 60-day declined. 90 day, from memory, 90-day went up $3 million, is that about right? Remember that slide? I think -- I don't have it in front of me. I think 30-day was down -- 60 to 90 was down about 16 million and that the 90 and over was up, like 3 million. So, we went over this with the Board yesterday. Remember that, Connie? So, the early stage is one quarter. Don't get too excited, but what I'm seeing, I'm not seeing anything really getting worse or anything tremendously getting better. I see us really stable from the last three to six quarters.

That's more attributable to the decline in the Hawaii economy kind of leveling out at this point?

I think so. Early on, Connie mentioned to you, I don't even remember when, a year ago or so, we had some cruise lines go to Japan, we had two airlines back out. Over the last three months, you hear so and so added a flight or a route. You hear that occupancy is up at the hotels, although the spend per person is down some. So, there are early triggers that you see that it's at least stabilizing.

Okay. That's good to hear. Thank you very much.

At this time, there are no further audio questions. I would now like to turn the call over to Management for closing remarks.

Thank you, everyone, for joining us today. As always, I'll be available for your additional questions if you have any. Thanks, again. Bye.

Thanks for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.